Thursday, March 29, 2018

Debt Oped

An oped on debt in the Washington Post. Growing debt and deficits are a danger. If interest rates rise, debt service will rise, and can provoke a crisis. Really the only solution is greater long-run economic growth and to reform -- reform, not "cut" -- entitlements. And the sooner the better, as the size and pain of the adjustment is much less if we do it now.

This is written with Mike Boskin, John Cogan, George Shultz, and John Taylor. George Shultz was the inspiration, and wrote the first draft. He radiates an ethic of government as responsible stewardship, and displeasure when he does not see such. It is a pleasure of my job at Hoover to work with such distinguished colleagues.

The Post gave it two headlines, in one "horizon" and in the other "doorstep," in different versions. The latter is a bit more alarmist than we care for. Like living above an earthquake fault, living on a mountain of debt can be quiet for a long time. Until all of a sudden it isn't. A pdf version

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A Debt Crisis is on the Horizon

By Michael J. Boskin, John H. Cochrane, John F. Cogan, George P. Shultz and John B. Taylor

We live in a time of extraordinary promise. Breakthroughs in artificial intelligence, 3D manufacturing, medical science and other areas have the potential to dramatically raise living standards in coming decades. But a major obstacle stands squarely in the way of this promise: high and sharply rising government debt.

President Trump's recently released budget is a wake-up call. It projects that this year, a year of relatively strong economic growth, low unemployment and continued historically low interest rates, the deficit will reach $870 billion, 30 percent greater than last year.

For years, economists have warned of major increases in future public debt burdens. That future is on our doorstep. From this point forward, even if economic growth continues uninterrupted, current tax and spending patterns imply that annual deficits will steadily increase, approaching the $1 trillion mark in two years and steadily rising thereafter as far as the eye can see.

Unless Congress acts to reduce federal budget deficits, the outstanding public debt will reach $20 trillion a scant five years from now, up from its current level of $15 trillion.
That amounts to almost a quarter of million dollars for a family of four, more than twice the median household wealth.

This string of perpetually rising trillion-dollar-plus deficits is unprecedented in U.S. history.

In recent months, we have seen an inevitable rise in interest rates from their low levels of recent years. Rising interest rates and increasing deficits threaten to build upon each other to send public debt spiraling upward even faster. When treasury debt holders start to doubt our government's ability to repay, or to attract future lenders, they will demand higher interest rates to compensate for the risk. If current spending and tax policy continue unaltered, higher interest costs will have to be financed by even more debt. More borrowing puts more upward pressure on interest rates, and the spiral continues.

If, for example, interest rates were to rise to 5 percent, instead of the Trump administration's prediction of just under
3.5 percent, the interest cost alone on the projected $20 trillion of public debt would total $1 trillion per year. More than half of all personal income taxes would be needed to pay bondholders. Such high interest payments would crowd out financing of needed expenditures to restore our depleted national defense budget, our domestic infrastructure and other critical government activities.

Unchecked, such a debt spiral raises the specter of a crisis. Some may think that such concerns are overblown, as there is no current evidence in financial futures markets that a crisis is on the horizon. But a debt crisis does not come slowly and visibly like a rising tide. It comes without warning, like an earthquake, as short-term bondholders attempt to escape fiscal carnage. Only in hindsight are we able to see the stresses building and bemoan that we did not act. While some insulation flows from the dollar's role as the global reserve currency, that is neither sufficient nor immutable, and relies on faith in the United States' eventual fiscal probity.

As is well-known, our deficit and debt problems stem from sharply rising entitlement spending. Without congressional action, the combination of the automatic spending increase per beneficiary provisions of these programs and the growth in entitlement program recipients as the population ages will cause entitlement spending to continue to rise far faster than U.S. national income and tax revenue.

To address the debt problem, Congress must reform and restrain the growth of entitlement programs and adopt further pro-growth tax and regulatory policies. The recently enacted corporate-tax-reform plan is a good first step, as it sharply increases the incentive to invest and grow businesses, which will increase incomes. The revenue loss, which amounts to about 0.4 percent of gross-domestic product in 2025, is not by itself a budget buster, considering both the offsetting revenue reflow from higher incomes and the far larger long-run entitlement explosion. Moreover, over the next decade, the tax plan maintains or increases the federal tax claim on GDP compared with recent levels.

Taxes alone cannot solve our budget problem. Funding programs as they are currently structured will require high taxes for all income levels, taxes that would sharply reduce economic opportunity and growth, which in turn will make funding entitlements that much harder.

If Congress acts now, it can avoid a fiscal collapse while continuing to provide help to people who need it. If Congress waits for a crisis - which may come when the United States needs suddenly to borrow significantly to address a financial meltdown, recession or war - the result will be fiscal and economic chaos, as well as painfully sharp cuts to programs that people rely on.

It is time for action. Fixing our fiscal problems is far easier now than it will be in the heart of a crisis. And if we cannot fix our problems now, in a time of peace and prosperity, just when can we do so?

The writers are senior fellows and economists at the Hoover Institution.

80 comments:

It seems to me that ill considered tax cuts and a big boost to military spending have played roles worth mentioning.

There is no problem with the US financial situation that a 5% to 10% average cut in consumption by Americans would not solve. This is not a crisis - just some bad short term choices driven by dysfunctional politics.

Your argument would be stronger if you explained EXACTLY WHY a standard of living cut of up to 10% is needed to improve the "financial situation" (by which I assume you mean get the debt down).

The debt can be cut any time and by any amount simply by having the Fed print money and buy back chunks of debt: i.e. continue with QE. The effect of QE on demand was pretty muted, thus I don't see there'd be a big effect from buying back the entire debt over a five year period.

The only standard of living reduction effect comes from the fact that giving creditors zero interest yielding cash in exchange for interest yielding debt would induce some of them to lodge their money elsewhere in the world, which would temporarily depress the dollar on forex markets, which in turn would depress US standards of living. But I can’t see that depressing living standards by even 5%, though clearly detailed calculations would be better that guess-work.

I believe the effects of QE on aggregate demand and inflation was "muted" (because it is evident there is evident price inflation in certain sectors of the economy) due to the FED's IOER (interest on excess reserves) policy, which caused banks to have excess reserve ratios of almost 100%! The quantity of money did not increase as it was retained by banks.

https://data.worldbank.org/indicator/MS.MIL.XPND.GD.ZS?end=2016&locations=US&name_desc=true&start=1960&view=chartUS defense spending as a percentage of GDP is near its historical low from the last 60 years. The data supports the conclusion that defense spending is depleted.

The level of ignorance exhibited by the authors is profoundly astounding. The US government debt is not a problem in any way shape or form. In fact, it can be repaid tomorrow without a negative repercussion. That would simply involve replacing government bonds with deposits at the Federal Reserve Bank with similar interest and maturities. The similar or even better risk/reward terms assure no change in investor savings/spending preference or desire to hold dollars. Not recommending this course of action, just pointing out that it is possible.

Yes, we can easily default on our onlijations like we did in 1932 and 1973, And we can do it smoothly as you suggest, with opportunistic and deliberate default via the Fed. Possibly keep inflation under 5% for a ten year period, dump some debt. It worked in 1973, except it took us ten year to rebuild finance. But the rebuilding was because it was sudden, Nixon defaulted unexpectedly over night. Instead, do it deliberately, dump about 4T of debt, all of finance is aware, all of finance can bet along the way and avoid coordination failure.

Do Deals: You MMT guys make my brain hurt. To assume that massive accounting entry changes can fundamentally change the risk/reward profile of debt holders with no implications on inflation or the dollar is baffling.

Matt, What "Do Deals" proposes is not "defaulting". It simply consists of replacing debt with cash: i.e. Do Deals is proposing more QE. No one has suggested that QE equals defaulting, and quite right: it doesn't.

Thank you Ralph.Matt: I really don't know what you're talking about. How did the US "default" in 1932 and 1973? As in, fail to make payment in dollars when the bonds came due?

Donkey: How is the Federal Debt in any way "risky" And how is a Federal Reserve Deposit not less risky? The Fed has the printing press. Hw can it default? (The Treasury may in fact default say if a Republican Congress wants to embarrass say the first Hispanic president by forcing a default for a few days.) But the Fed cabnnot be forced into a default - PERIOD.

We prefer default to extend and pretend, which is why we do it. Rather then try, for the fifth time, to invent a 'this time is different' theory. The time is gone for a no default theory, and we generally invent those theories after the fact, each generation conning the next.

When we include death and default, data matches theory. Even if MMT true, we prefer default to MMT. Since we like defaults, why fake it, add default to MMT, make the theory follow our preferences.

Do Deal: Just because the Fed has the printing press and can print currency to pay off any debts, it doesn’t mean investors would be happy about it! If the dollars investors receive back on their debt have significantly different purchasing power or foreign exchange rates than investors were expecting it can have extremely negative effects for the country. Just because there is no reason for the fed to ever technically default it doesn’t mean there can’t be an effective default.

Donkey: See my comment below regarding significant increase in the pool of GOODS AND SERVICES.

Mous: My proposal is a Job Gty as part of a Full Employment Fiscal Policy. Read the blurb instead of setting up strawman counterfactuals: http://mmt-inbulletpoints.blogspot.com/2017/09/im-just-responding-to-various-economic.html

Just recently, Prof Hausman wrote about the dark matter in debt, which consists of services and technology which may switch the debt from positive to negative. Also, there is this historic misfit of economic predictions with US debt, wherein during crisis money flowed into the US economy than leave it, which may keep interest rate levels low. Under such consideration, maybe situation is not that alarming as it seems.

Rubbish. The first comment beat me to it. "As is well known..." This is the typical delusional and hypocritical garbage spewed by Republicans that spend like drunken sailors on what they want, and blame the rise in spending on the things they don't want.

Take a look at how much money is spent on entitlements compared to everything else. Look at how future projections show interest and entitlement spending being more than 100% of tax revenues. Entitlement spending is already higher than defense spending. What are these things Republicans spend all this money on?

The starting point for the analysis is undisputable. Never ever in peacetime with unemployment at 4% the US has seen a deficit at present level – that is before the impacts of tax cuts & spending increases hit the bottom line. However, why are entitlements the only culprit mentioned in the op-ed? Entitlements - or welfare spending - is lower in the US than in almost all other rich countries. What is even lower is the level; no rich country has a lower tax level than the US (total government revenues vs GDP/GNI). Had Americans paid the same taxes as we do in other OECD countries, the budget would have been in plus! Sure, some entitlements should be reformed (as in all other countries) but it is the unwillingness to pay 'normal' taxes that explains the extreme weak US budget position.

The starting point for the analysis is undisputable. Never ever in peacetime with unemployment at 4% the US has seen a deficit at present level – that is before the impacts of tax cuts & spending increases hit the bottom line. However, why are entitlements the only culprit mentioned in the op-ed? Entitlements - or welfare spending - is lower in the US than in almost all other rich countries. What is even lower is the level; no rich country has a lower tax level than the US (total government revenues vs GDP/GNI). Had Americans paid the same taxes as we do in other OECD countries, the budget would have been in plus! Sure, some entitlements should be reformed (as in all other countries) but it is the unwillingness to pay 'normal' taxes that explains the extreme weak US budget position.

I suppose the focus on entitlements was driven by the following: (1) entitlements are by far the largest outlay; (2) have grown quickly relative to historic levels; (3) are projected to continue to grow quickly; and (4) cannot be quickly reduced in times of budget crisis. To me all this seems rational enough.

I appreciate your point that comparative analysis (looking to other countries) paints a different picture of entitlements than historical analysis. However the comparative approach does introduce a whole lot of confounding variables -- presumably challenging to address in the limited scope of an Op-Ed -- and is in no way clearly superior.

One aside: I think your assertion that other rich countries spend more on entitlement than the U.S. is wrong. They certainly spend more on social programs and income distribution, but not in the form of entitlements. That is (arguably) an important distinction in the context of a budget debate.

Over the same period that deficits increased by 30%, interest expenses increased by nearly the same ratio. We are in spiral.

What we want to avoid is pretending we won't have cefaults when every generation in our history defaults and rebuilds finance. FDR tried to do it smoothly with the 'nothing to fear' speech. Nixon did it in an overnight coup.

Economists, generally, lie about default because each thinks they have a cleaver math trick. None do, in fact defaults are part of free entry and exit and economists with smarts know it must happen. In other words, if defaults did not happen we would still be living in trees.

It not something to hide, we are expected to try and fail, it is OK, no need to freak, just try thinking it through

But what does public indebtedness even mean? These are some statistics from “The Economist” as of 2015 representing public debt as a percent of GDP:USA: 92%France: 100%Venezuela: 59%India: 54%China: 17%Russia: 8%Japan: 261%England: 100%Brazil: 55%

Its total nonsense. A sovereign (Treasury combined with the Federal Reserve Bank), like the US, that: a. issues, b. borrows in, and c. floatsits own currency, can NEVER run out of cash.I think the only countries above this doesn't apply to is France and Venezuela.

Donkey: If the money is used to implement a Job Gty as part of a Full Employment Fiscal Policy, why would there be any inflation? As long as there are unemployed folk, or folk in the Job Gty program, that can be pulled into private sector, added spending will result in business people going waky waky and producing MORE GOODS AND SERVICES, offsetting the issuance of additional currency - so NO INFLATION. http://mmt-inbulletpoints.blogspot.com/2017/09/im-just-responding-to-various-economic.html

Do deals: But there are players in the game outside the US. Foreign entities/countries finance our deficits. They might not continue if we announce that we’re done tracking or pretending to care about our debt.

With a Job Gty, the level of goods and services produced (public and private sector) increases and offsets the newly issued currency. The foreign currency value may rise or fall based on many factors. No reason to fall since goods and services rise. And if it falls, so what? Exports rise and imports fall. What's the problem again?

The US spends about 50% more in real terms for national security today than at the height of the Reagan buildup. But back then we faced a bona fide military adversary in the form of the old Soviet Union.

Entitlement spending is growing but largely due to an aging population and vastly expanded Veterans Administration outlays.

It does not help the US debt situation when people pontificate but obviously have agendas.

Still, I think going forward, the situation is hopeless. We should plan monetary policies in light of chronic deficits.

Should we ponder helicopter drops? Or sustained quantitative easing? Should the US lock in as much long-term debt as possible and then move to a higher inflation target?

"Should the US lock in as much long-term debt as possible and then move to a higher inflation target?"

You are looking for a painless technical fix; a slight of hand.

A serious plan to fix the US budget would: cut military spending; increase personal taxes; probably introduce a broadly based VAT; would certainly included higher gas taxes; would grind medical service providers and pharmaceutical companies on reimbursement rates; would invest serious public research money into ways to make medical treatments give better cost / benefit; criminal justice reform that reduces prison costs and increases work force participation.

Looking at the American political calendar, you are going to have a knock down drag out election over fiscal issues, broadly defined, in 2022 or 2024.

You don't have to get the deficit to zero. The accounting used is too wonky for that to be a serious goal. A more sensible medium term target is to stop the debt growing relative to GDP.

Significantly cutting entitlement spending would be a much simpler and more practical plan to fix the US budget. Though we could be like most developed nations in which people in the bottom 60% of the income distribution pay much higher percentages of their income in tax than do people in the US but I am not sure politically how that could ever happen at this point.

"Significantly cutting entitlement spending would be a much simpler and more practical plan to fix the US budget."

ROTFLMAO

"Entitlement" spending consists principally of Social Security, Medicare and Medicaid. If the American right believes that "significantly" cutting them is a "simple and practical" plan then they should campaign in 2018 on a forthright platform of cutting those spending programs "significantly".

I don't think so. If you are right countries like Germany, Finland, Australia should have collapsed long time ago. Care to explain Australia's $16 per hour minimum wage or their Medicare for all? The goal here is to redistribute wealth upwards. At least admit it. You will feel better.

If it's necessary to curb entitlements as suggested by Taylor, Cochrane & Co, how come some European countries have much larger entitlement programs than the US, but nevertheless have their debt under control? Reason is that they collect enough tax to cover the cost of entitlements.

There is no problem in principle in having entitlements gobble up anything between 0% of 50% of GDP: just collect enough tax to cover the cost.

Europe goes broke on a regular basis, every generation. The question is why we deny it. What is the purpose of denying a normal economic function? Why not just do default better today than last time. It is just an overton window problem, a sort of sneak we do.

The Federal Debt just doesn't matter. What matters is the growing wealth of the nation, which can best me nurtured by a high percentage of the population getting educated, working, and doing the best they can do. The Federal Debt, private debt, money outstanding, deposits, Reserve Deposits, stockholders: these are folks and instruments that have a stake in the wealth. A generation out, youngins come of age and want to work in exchange for a piece of the pie. Why should they care who owns or has a stake in the wealth. They won't get any of it until they work. - THE FEDERAL DEBT DOESN'T MATTER! Its a total irrelevant nothingburger.

Why stop at 50%? Is there some analysis that suggests that entitlement spending as a percentage of GDP poses no problem until it reaches 50%? Why not 100%? We can give everything to the government and that will solve everything.

Is it really so bad that the US government has borrowed a lot short-term? If the crisis comes, I think it will most likely be in the form of inflation shocks, not a debt spiral and defaults.

As a thought experiment, the Fed could convert all debt to reserves and set the rate to zero. In that case, in a simple FTPL world:

inflation = shock - the real rate,

where shocks arise from changing government solvency concerns. If the real value of debt is constant (no shocks), then inflation equals minus the real rate.

How costly are inflation shocks in today’s economy? Private parties can write inflation-indexed contracts, and to some extent do. Non-indexed bond holders would take a hit. Wages would be lower in real terms but would also be adjusted fairly quickly.

It could be bad for sure, but not Zimbabwean. Perhaps we’ll survive...

The Federal Debt is a nonsense stat that can be ignored; it shouldn't even be reported. There are 2 stats that need to measured and managed:

1) Unemployment as in keep it at ZERO at all times through a Job Gty as part of a Full Employment Fiscal Policy: http://mmt-inbulletpoints.blogspot.com/2017/09/im-just-responding-to-various-economic.html , and2) Inflation: as in measure monthly and keep it at a low comfortable level at all times.Conservative men with small hands are always measuring the wrong things.

That’s the nature of debt crises....the debt doesn’t matter until somebody worries they won’t get paid and somebody else believes them. Then the run begins, then liquidity and financing dries up, then crisis, then everybody wonders why there were no warnings or why we didn’t see it coming.

Yes, sudden bank rons, so what, they run down a tier, drop market value, declare some defaults. It is how MMT really works under friction. It is fine, nothing wrong as long as we don't have humans faked out with with the promise of frictionless adaption.

Donkey: When evaluating any debt situation, the first question to ask is: Does the borrower 1) Issue, 2) borrow in, and 3) floats its own currency. If it doesn't----> Debt might be a problem. If it does----> Debt can be ignored. Total nothingburger.

Do deals: No, that’s not the first question. Currencies don’t just have value because of those three things. Our economy is open and our exchange rates float. If a country borrows money, and it needs to continue to borrow for the foreseeable future from foreign entities, it cannot simply ignore the debt.

It is the lender who is the other counterparty in the debt situation. The central bank cannot be lender because it is market maker. Lender and borrower are semi independent classes. We do not even know the debt situation until the two parties make the bet.

MMT makes a fundamental error, no party really knows the current interest rate until after the fact. Loans never equal deposits, there is no provable method for all parties to Know a current cotrrect value of loans and deposits.

Donkey: We are not talking about the currency value. We're talking about ability to repay a loan. Liquidity can never be an issue in the sovereign that issues, borrows and floats its own currency. A sovereign does not need to borrow, much less from a foreign entity, unless it needs imports to survive. Then it may have to export also. - I don't know what you are talking about in your critique of MMT.

Defense spending as a percentage of GDP is basically at its lowest point in the last 60 years. Moreover, defense spending as a percentage of total government spending has also decreased. https://data.worldbank.org/indicator/MS.MIL.XPND.GD.ZS?locations=US&view=charthttps://www.usgovernmentspending.com/spending_chart_1935_2020USf_XXs2li111mcn_30f_Defense_Share_of_Federal_Spending

Anon: Does it matter AT ALL what other countries are spending? Does the power of adversaries matter? Have our borders or national security interests increased proportionally with GDP? Stop throwing out one data set and pretending that it tells the whole story.

Yes, that is true. But a better question is why are we spending so much on defense? Is there an imminent invasion? Most of it is spent protecting allies. Most of whom are rich enough to defend themselves. Why is a nation that represents 5% of the worlds population (or 25% of world output) expected to carry 50% of world "policing" costs?

"Growing debt and deficits are a danger. If interest rates rise, debt service will rise, and can provoke a crisis."

NO, WRONG. Growing debt is a problem - payments on the federal debt are guaranteed irrespective of economic performance. Deficits can be managed through the sale of either bonds (debt) or equity. With equity, risk lies with the buyer of the security. With debt, risk lies with the seller of the security (bankruptcy / insolvency).

"Really the only solution is greater long-run economic growth and to reform -- reform, not cut -- entitlements. And the sooner the better, as the size and pain of the adjustment is much less if we do it now."

NO, WRONG AGAIN. The only solution is for the U. S. Treasury to sell equity in lieu of debt - and the reason is quite simple:

The Federal Debt is a nonsense stat that can be ignored; it shouldn't even be reported. A very stable genius recently posted a blurb on the intergenerational aspects of the Federal Debt: http://mmt-inbulletpoints.blogspot.com/2018/04/the-kids-are-not-alright-truth-about.html

As it stands now, federal interest payments are made from tax revenue.As such, it is possible for the total interest expenditures paid by the federal government can grow to exceed total available tax revenue.

So to say that the Federal Debt is a nonsense stat misses what should be obvious (genius or not).

Yes, the federal government (minus central bank influence) could attempt Ponzi finance - make interest payments with the sale of new bonds - but I doubt it would be very sustainable.

Nonetheless, it is possible (and quite legal) for the U. S. federal government to sell perpetual bonds (no principle payments are made), have the central bank buy those bonds and remit the interest payments back to the U. S. Treasury.

In that specific case, the federal government NEVER makes any payments on it's debts - EVER.

Economics (at least I have heard) is all about incentives. There are plenty of incentive based reasons to reduce the federal debt that have nothing to do with "the children" or "inflation" or whatever other ridiculous reasons politicians put out for debt reduction.

The Federal Debt can be repaid tomorrow, actually call it Monday, by replacing with Federal Reserve Deposits. Easy Peasy. All this other debate about payments and growth, and sustainability are useless. See blurb on Full Employment: http://mmt-inbulletpoints.blogspot.com/2017/09/im-just-responding-to-various-economic.html

"The Federal Debt can be repaid tomorrow, actually call it Monday, by replacing with Federal Reserve Deposits. Easy Peasy."

Wrong. Even when the central bank buys government bonds, the liability to the tax payer still exists because:

1. The central bank can at any time sell those bonds back into the market.

AND

2. The central bank is not legally permitted to borrow on behalf of the federal government - meaning the central bank can't swap it's own debt for the federal government's.

The central bank can limit the liability to the taxpayer by remitting any interest payments back to the federal government (Treasury), but that is a choice that can be made and then undone at any point by the central bank.

Please, take some time. Read the Federal Reserve Act. Read the U. S. Constitution. Take an accounting class or pick up an accounting textbook.

Franky:RE: "...The central bank can at any time sell those bonds back into the market ... The central bank is not legally permitted to borrow on behalf of the federal government - meaning the central bank can't swap it's own debt for the federal government's. ..."• As I mentioned, I'm talking about having the Fed reprot to the Treasury. end of your line of unreasoning.

Thanks to a few abusers I am now moderating comments. I welcome thoughtful disagreement. I will block comments with insulting or abusive language. I'm also blocking totally inane comments. Try to make some sense. I am much more likely to allow critical comments if you have the honesty and courage to use your real name.

About Me and This Blog

This is a blog of news, views, and commentary, from a humorous free-market point of view. After one too many rants at the dinner table, my kids called me "the grumpy economist," and hence this blog and its title.
In real life I'm a Senior Fellow of the Hoover Institution at Stanford. I was formerly a professor at the University of Chicago Booth School of Business. I'm also an adjunct scholar of the Cato Institute. I'm not really grumpy by the way!